World markets hold breath after Italian election deadlock

Although returns in Italy’s internationally-watched election Sunday won’t be final for days, the White House, Wall Street, and the world financial community are now holding their collective breaths to see what happens next.

In a nation where debt is 120 percent of the Gross Domestic Product and foreign investors watch its economic conditions closely, the leader long credited with keeping Italy above water and not requiring a bailout from the International Monetary Fund and European Union is finishing poorly in the polls.

The pivotal figures in the formation of the next government now appear to be a former Communist, a comedian—and the irrepressible Silvio Berlusconi, who remains a force to be dealt with after three past stints as prime minister and more than 30 court trials on charges ranging from using government to benefit his media empire to inappropriate relations with a minor.

With more than half the Italian voters choosing the euroskeptic parties headed by Berlusconi or comedian Beppe Grillo, talk was beginning to spread across the ocean that the European currency and perhaps the European Union were on thin ice. Reuters reported Monday that the benchmark spread between the Italian 10-year bonds and their German counterpart widened from below 260 basis points to more than 300. Moreover, the Italian share index lost all previous gains following reports of an election results that can be called—for now, at least—a deadlock.

What happened?

With about two-thirds of the votes counted Monday evening, the center-left Democratic Party narrowly collected the most votes in races for the Italian parliament’s lower house (the Chamber of Deputies). But under Italy’s complex election law, the Democrats will get 54 percent of its seats. This could give Democratic leader and former Communist Pier Luigi Bersani the first crack at forming the new government and thus becoming prime minister.

But it’s not that simple. The top vote-getter in races for parliament’s upper house (senate) was the center-right People of Liberty party headed by Berlusconi. But Bersani’s Democrats must now deal with the prospect of a possibly more outrageous and controversial figure than the 76-year-old media titan known as “Il Cavaliere” (the knight).

In the twilight days of the campaign, there appeared to be a strong surge among voters to the new, online driven Five Star Movement, headed by comedian and blogger Beppe Grillo. According to unofficial returns, Five Star—often likened to the Tea Party in the U.S.—is running third in races for both the Chamber of Deputies and the Senate. That means that talks in forming a new government in Rome must include Grillo—who insisted throughout the campaign he will not enter into a government with any other party.

The platform of Grillo and Five Star includes suspending payment on the national debt and a referendum on remaining on the European currency, cutting the size of parliament in half, ending public subsidies to the political parties and newspapers, promoting renewable energy and encouraging small businesses.

Now 64 and a millionaire many times over, the Genoa-born Grillo was drawing record crowds in the final week of the campaign. Tens of thousands turned out for his election eve rally in Rome’s San Giovanni Piazza. Five years after he launched Five Star, the comedian candidate has more than one million friends on Facebook and 900,000 followers on Twitter.

What is particularly interesting is that Grillo insisted he was merely a “megaphone” for his movement and was not himself a candidate for parliament. There is even some legal question as to whether he can serve in government, as Grillo was convicted of manslaughter for the death of three passengers in his car for an accident.

Placing fourth with 10 percent of the vote—barely enough to qualify for seats in parliament—was the man that the financial community (and almost surely the Obama administration) rooted for. As Italy’s non-elected prime minister since the debt crisis forced Berlusconi out a year ago, economist Mario Monti oversaw an austerity program of cuts in federal spending and raising some taxes. While this clearly kept Italy’s economy afloat, it did not help Monti’s new Civic Choice Party and the prime minister paid dearly for his making hard decisions.

As to what’s next for Italy and what kind of government it will have and whether there will be another election next year, that will be decided in the weeks ahead. For now, the results do not inspire a lot of confidence in the Italian political system—or the nation’s investors from overseas.